Real Yield Near Crisis Lows, BlackRock Bullish: Australia Credit

Wes Goodman

August 13, 2014 — 11:43 PM EDT

Australian bond gains pushed a measure of sovereign yields close to the lowest level since the global credit crisis. BlackRock Inc. and Mizuho Asset Management Co. say the rally has further to go as the economy stumbles.

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Ten-year notes yielded as little as 28 basis points on Aug. 8 after accounting for inflation, one basis point from the lowest level since January 2009. The premium investors earn for buying 10-year government debt in Australia -- which offers the highest yield among AAA rated nations -- instead of the U.S. narrowed to 86 basis points last week, the least in almost eight years. BlackRock predicts a narrowing to about 70 basis points by early next year.

“High-quality and high-yield bond markets are a pretty rare beast and Australia stands out as one,” Stephen Miller, a Sydney-based money manager at BlackRock, said by phone yesterday. “The 10-year bond can rally a bit in an environment of sub-trend growth and declining inflation.” The company is the world’s biggest money manager with $4.59 trillion in assets.

Australia’s sovereign bonds are on pace for the best annual gains since 2011 as traders bet the Reserve Bank, which cut forecasts for growth and inflation last week, will leave its benchmark rate at an all-time low for at least a year. Reports this month showed the unemployment rate surged to a 12-year high in July, while wages grew in the second quarter at the slowest pace on record.

‘Very Vulnerable’

“The economy is very vulnerable,” said Yusuke Ito, a bond investor in Tokyo at Mizuho Asset Management, which oversees the equivalent of $39.1 billion. “Bonds are not expensive yet. Monetary conditions will be kept quite loose going forward,” he said in a telephone interview Aug. 11.

Ten-year notes yielded 3.43 percent as of 1:22 p.m. in Sydney, dropping from 4.24 percent at the end of last year. The rate will fall to 3 percent by Dec. 31, Ito said.

The RBA projected gross-domestic-product growth of 2.5 percent for this year, down from a 2.75 percent forecast three months earlier, in its monetary policy statement Aug. 8. The central bank lowered its forecast for a measure of inflation that strips out volatile items to 2.25 percent from 2.5 percent in May.

The decline in mining investment will “weigh more heavily” on the economy than it has, while non-mining sectors will “improve a little,” the central bank said.

Jobless Rate

Australia’s unemployment rate jumped to 6.4 percent in July, versus 6.2 percent for the U.S., topping the American level for the first time since 2007. Wage costs climbed at an annual pace of 2.6 percent in the second quarter, the slowest pace in data that goes back to 1998.

The Australian dollar has weakened 1 percent in the past month. It traded at 92.98 U.S. cents today. The nation’s sovereign bonds returned 6 percent this year through yesterday, compared with 4 percent for Treasuries, Bloomberg World Bond Indexes show.

Economists surveyed by Bloomberg predict GDP growth will be 3.1 percent this year before slowing to 3 percent in 2015. The opposite is happening in the U.S., where economists project the pace of expansion will accelerate to 3 percent next year from 1.7 percent in 2014.

Australia’s 10-year yield dropped to 3.28 percent on Aug. 8 following the RBA statement, marking the smallest premium to Treasuries since October 2006. The yield is still the highest among 25 developed bond markets tracked by Bloomberg after Iceland, Greece, New Zealand and Portugal.

The South Pacific nation has top-level AAA rankings from Standard & Poor’s, Moody’s Investors Service and Fitch Ratings.

Bonds Expensive

Bill Bovingdon, the chief investment officer at Altius Asset Management Pty in Sydney, said he’s avoiding long-term government bonds as they’re expensive. The RBA has already cut rates to a record low, and Bovingdon said Aug. 12 that he questions how much more they can fall.

“We have a very stimulative position in place already,” said Bovingdon, who oversees the equivalent of about $510 million. “How much lower does the RBA take rates? It’s possible they could go a little lower. As much as is going to be helpful has already been done.” The Australian 10-year yield may approach 4 percent by year-end, he said.

Traders are betting Australian policy makers will reduce the benchmark rate by seven basis points during the next 12 months, swaps data compiled by Credit Suisse Group AG showed. They’re preparing for 21 basis points of increases in the U.S.

Australian yields may push higher because of an increase in U.S. borrowing costs, the global benchmark, said Alan Oster, the chief economist for National Australia Bank Ltd., the nation’s largest lender as measured by assets. Oster predicts Australia’s 10-year yield will rise to 3.55 percent by Dec. 31.

Even so, investors who bought today would earn about 0.4 percent because interest payments will make up for price declines, according to data compiled by Bloomberg.

The record-low RBA rate combined with inflation that’s in check and rising unemployment will support government debt, Oster said.

“They’re all bullish for Australian bonds,” he said in a phone call yesterday. “We’re not seeing a major selloff.”